On John Taylor´s “Reassessing the recovery”

What are the implications of all the recent economic reports (January employment, 4th quarter GDP, CBO’s downward revision of potential GDP) for an assessment of the recovery from the 2007-09 recession? In my view, they still indicate a very weak recovery. As I have argued, a good standard of comparison for this recovery is the most recent recovery from a very deep recession, namely the one that ended in 1982, and I have offered a series of charts to make the comparison easy and objective. Here are updates of those charts based on the latest data.

The first chart shows real GDP during the 10 quarters since the end of the 2007-2009 recession along with CBOs recently revised estimate of potential GDP. The chart clearly shows that the economy has yet to recover back to its potential. The only real difference from earlier assessments is that CBO has slightly lowered its estimate of potential.

For comparison, the next chart shows the recovery back to potential in the 10 quarters following the 1981-82 recession. The difference between the two charts is striking, and is why one can say that the current recovery is a recovery in name only.

That´s true as far as it goes, but it does not explain the “world apart” difference between the two recoveries. To do so we have to appeal to the behavior of nominal spending (NGDP) in the two instances. The following chart helps to understand the difference.

In the 2007-9 “great recession” nominal spending, an “object” under the control of the Fed, “tanked” and has recovered only agonizingly slowly. Something very different happened during 1981-05. Nominal spending only “relented” and then “shot up” at a rapid clip. The reaction of real output in the two instances is commensurate!

Taylor should give up the “output gap” methodology. As recently argued by James Bullard of the St Louis Fed:

I have argued that the “large output gap” benchmark, in which current economic performance is continually compared to the bubble-influenced mid-2000s, may not be realistic. Instead, one may want to interpret the recent U.S. experience as a one-time, permanent shock to wealth.

The “output gap” methodology is subject to different calculations and perceptions; in a way that talking about nominal spending is not!